Navigating Supply Relationships In The Turbulent World Of Coronavirus Disruption

by John T. Shapiro

A FREEBORN & PETERS LLP WHITE PAPER

ABOUT THIS WHITE PAPER Businesses throughout the globe that rely on or service supply chains are experiencing COVID-19’s disruptive impact. The altered marketplace should prompt your company to take proactive steps to manage the disruption to its supply relationships. This White Paper highlights key issues and strategies you can use to protect your company The ongoing COVID-19 (“coronavirus”) How should your company assess and and its supply relationships. pandemic is having an unprecedented manage supply relationships and navigate adverse impact on trade and commerce. existing and future disruption caused Businesses throughout the globe by the coronavirus? No one-size-fits- supply chain dynamics and experienced that rely on or service supply chains, all solution exists. But, a mix of three at helping to resolve disputes between whether simple or complex, domestic primary considerations will allow your supply partners. or international, are experiencing the company to better control its fortune pandemic’s disruptive effect. even where current-day realities render This White Paper highlights key issues for supply relationships uncertain and more use by your company’s team in protecting Purchasers and suppliers of goods and difficult to maintain and manage: the company and its supply relationships services are assessing their rights and 1. Understand your company’s existing in the turbulent global marketplace the obligations toward one another. In supply agreement rights and coronavirus pandemic has created. determining its strategy for addressing obligations disruptions, it is important for your 2. Nurture current supply relationships Step 1: Assess Your Company’s company to keep in mind that it may 3. Heed lessons learned in forming and Contractual Rights and Obligations be both a purchaser and supplier in the managing future supply relationships The altered marketplace should prompt same supply chain. Actions your company Each is complex. For and embolden companies to take may take as a purchaser in response to many companies, efficient and effective proactive steps to manage the business a supply partner’s inability to fulfill a assessment, relationship management, and legal consequences of disruption supply obligation may be taken against and synthesis and application of lessons to their supply chains and relationships. the company in its as a supplier learned to future company operations and Rote reliance on trust placed in supply if it is unable to fulfill obligations to a relationships will require a team approach. partners to offer a remedy is foolhardy. subsequent purchaser of the company’s This includes seeking input from and the Proactive management starts with products. assistance of legal counsel familiar with understanding your company’s rights and obligations so that your company can design and implement the inclusion of a clause in the parties’ supply an informed strategy. Considerations that inform decision- agreement may supersede application of an alternative theory, making regarding supply chain rights and obligations include: even if the force majeure provision does not apply to the particular cause of the disruption, the notion being that the Identify Governing Agreements and Law. Your company’s parties specifically allocated risk of the type of disruptions assessment of its supply relationship rights and obligations that would relieve performance. Therefore, your company starts with review and understanding of relevant supply should assess each potential avenue for relief under the agreements. This review should take into account the governing law in determining—and before implementing—its particular law that governs interpretation of each agreement strategy for addressing its inability to comply with its supply and relationship. Governing law may differ with respect to or purchase obligations. particular upstream and downstream parties in a supply chain and compel different strategies for different partners of your Identify and Maintain . It is important for your company within the same supply chain. company to keep in mind that each potential theory for relief from non-performance sets a high, fact-intensive bar Identify and Analyze Potential Legal Theories that may for partaking. Courts and other tribunals typically construe Afford Relief. No doubt, numerous companies that are unable each legal theory narrowly. Identifying relevant facts is vital to fulfill their obligations as a result of the coronavirus hope to assessing which legal theories support your company’s to claim the pandemic as a force majeure event, provided a situation. So too is maintaining evidence that reflects those force majeure clause is included in their supply agreement. facts, especially if your company subsequently has need to The purpose of a force majeure clause is to excuse prove an applicable defense or justify particular conduct. nonperformance where circumstances beyond the control of Because it is reasonable to anticipate a dispute will ensue, the parties thwart compliance. your company should implement a hold on information that relates to the disruption and the remedy your company Whether a supply disruption caused by the coronavirus implements. pandemic will constitute a force majeure event that excuses performance will depend on the particular wording of the If your company’s supply partner declares that a force force majeure clause. Where a clause includes terms such as majeure or another legal theory relieves it of its obligation to “pandemic” or “government act in response to an emergency,” supply the company or purchase its products, your company a company is more likely to be in a position to assert that the should not simply accept its partner’s word for it. Rather, your coronavirus is a force majeure event that excuses its non- company should ask its partner for evidence of its inability to performance. The World Health Organization has declared the supply or purchase and its efforts to mitigate the disruption. coronavirus a pandemic. And, governments around the world Further, if that supply partner’s inability to supply causes the have declared their own emergencies and have implemented company’s own inability to supply product to another supply quarantines, stay-in-place orders and other measures to stem partner, your company should be careful to document that the virus’ spread that have the effect of disrupting supply impact. chains. Consider Impact of Remedy on other Obligations and In the absence of a force majeure clause altogether or a force Aspects of Operations. The strategy assessment should majeure clause that does not encompass a coronavirus-related include consideration of other clauses in the supply disruption, other performance-relieving legal theories may agreement and other agreements, such as financing apply, including under , such as , agreements, that may be impacted by a declaration of and commercial frustration, the Uniform force majeure or notice of other remedy. In addition, the Commercial Code and the U.N. Convention on the Sale of assessment should include review of insurance policies to Goods. Generally, these avenues for potential relief consider determine whether your company is covered for losses whether an unexpected, intervening event occurred, the non- arising out of direct interruption of its operations as well as occurrence of the event is a basic assumption of the contract, disruption to the company’s supply chain, including failures of and the event makes performance impossible or impractical or upstream suppliers or downstream customers to comply with it obviates the purpose of the agreement. contractual obligations to the company. Insurance coverage for losses related to supply chain disruption may impact the As with the law on force majeure, your company must be strategy your company ultimately implements. weary of legal generalizations and mindful of the numerous permutations to these alternative legal theories, some jurisdiction specific. In the same vein, in some jurisdictions A Freeborn & Peters LLP White Paper 2 Mitigate the Impact of Disruption. Your company also should the event allows the company to permanently alter the assess its ability to mitigate disruption to its performance, supply agreement terms or terminate the supply relationship even if mitigation results in a greater cost to the company. altogether. Typically, additional cost to comply with a supply obligation alone does not excuse non-performance. But, careful review Be Mindful of Notice Requirements. A supply agreement or of the supply agreement, underlying facts, and governing law governing law may require that your company provide its may reveal a viable argument that additional cost to comply supply partners with prompt notice of a disruptive event. is a hardship that is encompassed by the force majeure clause Failure to provide prompt and adequate notice, in some cases or other legal theory. Moreover, even if efforts to mitigate are within a particular time frame, may result in waiver of the not successful, your company’s efforts nevertheless would right to rely on the force majeure clause or other legal theory. be relevant to its declaration of force majeure. First, your Therefore, your company’s strategy assessment must be done company would satisfy a mitigation effort should governing efficiently as well as effectively. Of course, if the period of law require such attempt before it may rely on a force majeure time in which to provide notice is short, your company may event to excuse performance. Second, your company’s efforts be required to provide notice of a disruptive event before it is likely would demonstrate that the force majeure event indeed able to complete assessment of its rights and obligations and rendered performance impossible. applicable defenses. Whenever issued, your company should be careful to avoid unnecessary statements that might harm Similarly, if your company receives notice from its supplier its position as to one or more other supply partners. The that the company believes is without merit (for example, the company also should be mindful of providing timely notice to supplier’s circumstances do not constitute a force majeure its insurers, and ensure that any notice provided to a supply event or the supplier should be able to mitigate its non- partner is consistent with notice of a covered loss and any performance), the company should assess whether it has a other steps an insurance policy may require. duty to mitigate the damages its supplier causes. Whatever the reason your company mitigates, it should keep careful Step 2: Nurture Existing Supply Relationships in the Face of record of its efforts and costs to mitigate. Disruption and Position Company for Amicable Resolution of Supply Interruptions In the event that your company is able to continue to supply Practically, a supply chain is about the relationships amongst one partner but not another because of the disruption, the the parties who comprise it. Those relationships have a company should tread carefully. Supplying one customer business, as well as a legal, character. Therefore, as it assesses but not others with the same or similar products may negate its options and strategies, your company should communicate or otherwise undermine the company’s force majeure with and seek information from its suppliers and customers declarations. The terms of your supply agreements and regarding the impact of the coronavirus on their ability to governing law may provide guidance should your company meet supply and purchase obligations. find itself in this situation. Before doing so, your company should map its supply Dispute Resolution. Your company’s strategy assessment and chain. Knowing who its suppliers are and where they are design also should include consideration of the venue in which located, and who and where their suppliers are, will clarify any ensuing dispute would be resolved. As with governing law, with whom the company should focus its efforts, facilitate your company’s approach to addressing a supply disruption assessment of information, reveal the potential for further may be guided by the ability to litigate or arbitrate in a venue disruption of supply relationships, and serve as a map for that is familiar and favorable to the company. Conversely, if a pursuit of amicable resolutions and for devotion of resources lawsuit or arbitration would enmesh your company in a foreign to find other supply solutions. Your company’s suppliers and jurisdiction, much less one where the governing law and customers may find themselves facing similar predicaments procedure are unfamiliar or unfavorable to the company, your and, as a result, be willing to renegotiate a supply relationship company’s decisions may be guided by the goal of achieving in a manner that achieves the parties’ respective needs an amicable resolution to the supply disruption. without need for further dispute resolution.

Duration of Disruption. Even if your company is able to Armed with accurate information about its supply chain and take advantage of a force majeure clause to excuse its non- with knowledge of its contractual rights and obligations, performance, that excuse may only be temporary in duration, your company may be able to negotiate with its suppliers until the disruptive event ends. The company’s assessment and customers resolutions that meet both the company’s of strategy should include review of the supply agreement immediate and longer-term needs and avoid supply disputes and the law that governs it in order to understand whether that tend to be disruptive themselves and expensive to A Freeborn & Peters LLP White Paper 3 resolve. In turn, irreparable damage to your company’s Consider, for example, the Iowa Supreme Court’s 2008 important supply relationships may be spared and harm to opinion in The Pillsbury Company, Inc. v. Wells Dairy, Inc. Wells your company’s hard-earned brand reputation avoided. produced ice cream for Pillsbury until Wells’ plant exploded. Wells claimed it was excused from its further performance under the following force majeure provision: Step 3: Take Heed of Supply Relationship Lessons this Pandemic Offers FORCE MAJEURE: Neither party will be liable for delays Of course, even with the best planned supply relationships, or suspension of performance … caused by acts of God problems may arise. With increasingly global and complex or governmental authority, strikes, accidents, explosions, supply chains, companies of all types face unprecedented floods, fires or the total loss of manufacturing facilities challenges in ensuring that they receive from their supply or any other cause that is beyond the reasonable control partners the products, services and benefits for which of that party (“Force Majeure”) so long as that party they bargain. Recent national and global events – natural has used its best efforts to perform despite such Force disasters, terrorism and war, changes in governmental Majeure. regulations, market instability, epidemics and, now, the coronavirus pandemic – underscore the critical need for The trial court found the clause ambiguous because it was your company to assess the impact of risks on its supply susceptible to differing meanings depending on the language chains and relationships – “what ifs?” – both foreseeable and modified by the phrase “that is beyond the reasonable unforeseeable. control of that party.” If the phrase modifies “acts of God or governmental authority, strikes, accidents, explosions, Risks inherent in a particular supply relationship can floods, fires or the total loss of manufacturing facilities or any be managed through proactive assessment and careful other cause,” the trial court found that the explosion would contracting that addresses business and legal issues unique not excuse Wells’ nonperformance if the explosion were not to the relationship. Critical considerations (each worthy of its beyond Wells’ reasonable control. But, if the phrase only own alert) include: modifies “any other cause,” Wells’ non-performance would be excused even if the explosion were within Wells’ control. • Careful assessment of supply chain risks and vulnerabilities; The Iowa Supreme Court reversed, holding as a matter of law • Thoughtful preparation for, and careful negotiation of, that the phrase “that is beyond the reasonable control of that the supply relationship in light of business needs and party” modifies all of the events the parties identified in the risks and vulnerabilities identified, including careful force majeure clause. The Court found that the clause must be consideration of terms that afford your company interpreted in light of the purpose of a force majeure clause, protection should the supplier falter; the allocation of risk if performance becomes impossible or • Precise drafting of supply agreement terms that reflect impractical as a result of an event that the parties could not the parties’ obligations and expectations; anticipate or control. The Court noted that the parties did • Vigilant management of the supply relationship; not negotiate what events would constitute a force majeure • Specific mechanisms for efficient dispute resolution; and event, which rendered Wells’ post-explosion interpretation • An exit plan, including broad termination rights. of the clause unreasonable. The Court reasoned that if Wells had wanted the parties to deviate from the typical purpose One consideration – precise drafting that reflects the parties’ of a force majeure clause, it should have bargained for and obligations and expectations – warrants further mention here negotiated such deviation. Further, the Court noted that given this White Paper’s focus on how to navigate supply allowing Wells’ negligence to excuse its performance would relationship disruptions caused by the coronavirus pandemic. defeat the purpose of the supply relationship, for Wells to A well-planned and well-written force majeure clause is critical provide Pillsbury a specific amount of ice cream within a to protecting your company’s interests. Often, companies defined period of time. relegate the force majeure clause to boilerplate, adopting a clause used in a different supply agreement or agreeing to a The Iowa Supreme Court’s admonition regarding negotiation clause proposed by the would-be supply partner. Although is prescient. Unanticipated events beyond the parties’ control certain concepts pertinent to your company’s business may that prevent performance occur. Your company’s negotiations permit use of boilerplate in its supply agreements, for some with its supply partners should account for such possibilities, situations and relationships boilerplate, and any poorly- including pandemics and government actions to stem their conceived list of unforeseeable and uncontrollable events or spread, and clearly allocate the parties’ respective risks, rights syntax carried over, can backfire. and obligations. A Freeborn & Peters LLP White Paper 4 Conclusion The nature and scope of the adverse impact of the coronavirus on supply chains and relationships continues to evolve. Far reaching disruptions are inevitable. In the coming weeks or months, many businesses are likely to receive notice from a supply partner that the coronavirus, or government-ordered action to stem its spread, constitutes a force majeure event that excuses the partner’s performance. Whether notice of a force majeure event, or assertion of another legal theory excusing performance, will succeed will depend on the particular terms of the supply agreement and the particular facts and circumstances giving rise to the disruption, the foreseeability of the disruption at the time at the time the supply relationship was formed and governing law. Practically, whether such notice disrupts your company may depend on your company’s relationship with the supply partner and preparation for disruption. Proactive management of supply relationships, understanding rights and obligations between supply partners, and seeking practical solutions to supply disruptions are likely to be the best medicine with which to protect your company against the ill effects should the coronavirus take hold of its supply chain.

If you have any questions, please contact John Shapiro ([email protected]; (312) 360-6389) or visit Freeborn’s COVID- 19 webpage. Freeborn has published multiple alerts regarding the effect of COVID-19 on businesses, and would be pleased to advise you on your company’s specific supply agreements, insurance coverage, and other aspects of its operations.

ABOUT THE AUTHOR John focuses his practice on solving clients’ complex business John T. Shapiro disputes, including through litigation, counseling clients on Partner regulatory, business and employment issues, drafting supply Chicago Office and related agreements, providing general corporate and (312) 360-6389 management advice, and assisting clients to establish and [email protected] maintain productive business relationships that further clients’ business interests. As Leader of Freeborn’s Food Industry Team, John provides ongoing legal and business counseling to a variety of food and beverage clients. Among other areas, John focuses on food safety, regulatory compliance, supply chain management, recall and other crisis management, and litigation. John believes that keys to success in the food and beverage industry include establishment of productive supply chain relationships and careful contracting that memorializes those relationships, identifies, allocates and mitigates risk, and accounts for the applicable regulatory regimen and other governing law.

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